Monday, September 13, 2010

The Good: Hup Seng Industries Bhd

Ping Pang Chiao Chiao Bing, that is what I can think of when someone mentions Hup Seng to me - well, not that bird thingy of course. Anyway, kiam piah or ham peng or sien bing or in ABC cream crackers, that's what they are famous for anyway. Business-wise, they have been around for decades but I have know this biscuit since I was 7 and I believe it has been around longer than my age. Although I have to admit, I don't really like the biscuit when I was younger (lack of taste) but as I grow older, it starts to taste pretty good.

Founded by Mr Kuo Choo Song and Kerk Chu Koh, Hup Seng has grown into one of the largest biscuit manufacturer in Malaysia with about 1400 employees. Their business model is pretty simple; make biscuits, distribute and then sell. And yea, since they have acquired In-Comix, now they are distributing instance coffee as well.



What got me into this business is its quite recent announcement of a special dividend that cause a sharp increase of its stock price. Special dividend can mean two things to me, superb cash generating business or "irrationally" managed business. Perhaps maybe, someone inside is messing around with the market.

Historical Business Performance


For a start, Hup Seng is not the most exciting business in the world. Revenue have been relatively flat with CAGR of 3% and profit after tax at about 8% (1998-2009). So, nothing to shout about really. Plus there is an indication that it doesn't have pricing power to its products (I don't really eat biscuit that much, but I hope you can tell me).  Graph below shows a PAT margin and we can clearly see how its margin got squeezed in 2004. The improved margin in 2008 and 2009 is largely due to raw materials price drop - Or are they?


Lets have a deeper look into their quarterly performance on the graph below.


If we could remember well, the crisis hits somewhere between Q3 and Q4 2008 and commodities prices are at their peaks still in Q1 and Q2. Plus a look at their SGA expenses in 2007 and 2008, there isn't much changes which means no cost cutting in terms of staffing or salary or even advertisement. With this, I could conclude, prices of their products have been adjusted and 2009 improved margin benefited from that adjustment. 

Hup Seng is not just a pure biscuit player, after its listing, it acquire 100% stake in in-Comix so they are selling instant hot drinks as well. In fact, they themselves have a good products mixes of varieties of biscuits such as Deluxe sandwich, cookies and all other kinds of biscuit. The closest listed competitors I could find is Hwa Tai.


The graph above shows the gross profit margin between Hup Seng and Hwa Tai and clearly we can see, Hup Seng consistently performed better than Hwa Tai which signifies Hup Seng competitive advantage over its competitor. On liquidity wise, Hup Seng has seen to be much prudent versus its counterpart who stays below 1 over the past 5 years. And as of today, Hup Seng has no long term debt and has a cash of more than RM47million which translate to nearly RM0.39 per share. That is almost 22% yield if they were to give all of them back as dividend.




Return on Capital Emplyoed (ROCE), has definitely improved ever since the price adjustment although, I expect it to reduce to around 10%-15% when raw materials prices pick up in which they will...sooner or later.


What I like about Hup Seng is its exports which contributes almost 30% of its revenue. Its products are exported to 25 different countries mostly in Asia some in Australia and Africa. Its export growth outperform its local business with a double digit growth rate of 10% per annum versus 1.2% local CAGR. The likely biggest source of growth is the overseas business.



Valuation

Hup Seng has a pretty simple business model with simple products. It has 3 subsidiaries one which is a biscuit confectionery, the other is to distribute and sells and the one it acquires, InComix. It is not a great business and some of its products compete in a pretty competitive F&B business industry against the likes of Kraft and Nestle. Hup Seng's competitive advantage is its relatively lower price or maybe some customers who prefer its taste better than the other. However F&B industry is unique, as the advantage of one product over another is very subjective to consumers' personal flavor. Plus, it could be difficult to duplicate although it could still be easily substituted. Unless if it has a champion products like Coca-Cola or Kraft's Twisties. It sure does have the ability to survive and generate cash especially if we look at how it turns around in 2008 when it is squeezed to almost death (well red actually) in 2007.



To do a DCF valuation on a business with loads of cash like this may not serve its justice. But still, no one knows what are they going to do with its cash and they could well end up like Genting Malaysia. We should get too excited about the recent special dividend unless we see they consistently doing that as they may just do it to keep some of its shareholders happy.

Revenue: I don't think Hup Seng is going to perform above industry standard of 6%, so I think they'll probably grow at the average of 3%. Local business is pretty much saturated so their source of growth is likely to be from its overseas exports.
Cost of revenue would stay at 73% while SGA expenses should be about RM41million all years.
I took its average Capex for RM5.1million for machine maintenance and possibly upgrade.
Tax about 25% and terminal growth value at 3% as well.
Discount value of 10% and Margin of Safety of 20%.

That would give Hup Seng a fair value of RM1.05 which is way over valued given its current price of RM1.78 -even if you add in its RM0.39 cash.

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